Santa Monica Partners founder Lawrence J. Goldstein and his colleague Josh Eudowe know a thing or two about the stock market. Since 1982, their flagship fund (open only to accredited investors) has trounced the S&P 500 with a 20% gross return and, after fees, a 15% annualized return. In the past 24 years, they've only had five down years, of which just one was greater than 10%.
I first got interested in SMP after reading of its battles with Warwick Valley Telephone's (Nasdaq: WWVY ) management. I called up Larry to see if he could provide some insight for myself and fellow Fool readers, and I came out thinking that this guy is like a stock-market encyclopedia. The following is the recount of a fascinating conversation I had with Larry.
Emil Lee: I read Predator's Ball and Den of Thieves, and I found it interesting that you started out at Drexel -- can you tell me about that experience?
Larry Goldstein: I actually joined Burnham & Company (Drexel Burnham Lambert's predecessor) as the lowest man on the research-department totem pole. The inquiries would come in, such as "Does General Motors (NYSE: GM ) pay a dividend?" I'd look it up, write out the answer in a "wire" format and send it to our teletype department via a container placed into our vacuum pipe system that ran throughout our offices (nobody ever heard of a computer in those days).
Sometimes I'd get a question on a company the analyst did not cover -- I'd get a chance to research them. One company I found was Overnite Transportation (now part of UPS (NYSE: UPS ) , selling at $3.50 [per share], earning $2.26 [per share]. My boss wouldn't let me put out a report on it due to illiquidity -- it was trading on the Pink Sheets. He said, "Hey, kid, this is an institutional research company, we don't write on Pink Sheet companies."
This was my first exposure to both the bargains in the Pink Sheets and also to the "institutional mentality." Later, the company had millions of shares outstanding, was trading on the NYSE, and was bought out. When I first bought the stock, I bought 100 shares, and my $3,000 investment became worth over $100,000.
I created industries because the senior analysts covered all the major industries, so I had to look in all the nooks and crannies. I first covered trucking companies, Roadway Express (bought out by YRC Worldwide (Nasdaq: YRCW ) ), Denver Chicago Trucking, Merchants Fast Motorlines, and Overnite Transportation. All of those turned out to be spectacular investments.
In 1974 to 1978, I became extremely positive about a company that went into bankruptcy. I bought stock, bonds, and customer claims in Interstate Department Stores when it declared bankruptcy, which was the largest bankruptcy in history at the time. They had a gem in that company -- Toys "R" Us. I bought those shares for four years from pennies up to $4 a share. When the bankruptcy was over, I had the largest position in the stock -- at their peak in the late '80s, the shares had split about 30-to-1 and were trading at about $50 [per share].
Later, after Burnham bought Drexel Firestone, there was a kid in the back room with green eyeshades named Michael Milken who, with a limited amount of money, traded bonds. Nobody knew what he was doing. Later on, Mike used to give lectures on junk bonds (which were called unrated bonds back then). He often said, "It's the triple-A companies that go bankrupt; it's the low credits, the triple-Cs, that move up toward becoming triple-As." That stuck with me.
EL: What motivated you to become a shareholder activist?
LG: All my life, I've never been one to give up. My dad inculcated in me that the bigger they are, the harder they fall. I want everything that I as a shareholder am entitled to -- nothing more, but nothing less. Companies say, "If you don't like the stock, sell it." I don't buy that. If I did all the work and research/analysis and I own it, I'm not going to sell it out because of the next-quarter result or next-year result. I want to be in it for the long haul, ideally for life.
I have not been afraid to call the head of a company to tell him he's not doing something right. I don't tell him that I know everything and he knows nothing; I tell him, "Have you considered such-and-such?" One of my best questions to a company manager is, "What are your seven biggest problems?" Most people start to enumerate them. Sometimes someone says, "I don't have any problems." That stock's a sale.
EL: Would you describe yourself as a long-term investor?
LG: If you try to pick tops and bottoms -- which I believe is an impossible proposition -- you have a silent partner, Uncle Sam, in New York. Capital gains taxes could run you over 25%. Much better to let your winners grow over time and to seek out stocks that you don't move in and out of like a bee buzzing around honey. You also don't want to find yourself in a deep hole. If a stock drops 50%, you have to earn 100% just to ... get even, and that is extremely difficult.
EL: Can you talk about Blair (the first investment SMP made for its new activist fund)?
LG: The first company that I decided to invest in [in] spring of 2004 was Blair (AMEX: BL ) . They were a 100-year-old company that sold apparel via catalog to the older population. I noticed they had $180 million in receivables from company credit cards. This is a superfluous asset which can and should be turned into cash. The suggestion I made was, "You can sell the receivables from the credit card, and sell the card infrastructure to companies that would be not only willing to buy the operations, they'd also help you with marketing." They looked at me like I was from outer space. Basically, I said, "They will pay you a premium for the $180 million of receivables." One year later, they took my advice. They also did a Dutch tender offer. We bought the stock in the low $20s, they did their tender at $42.50 per share -- they bought more than half their shares, and doubled their dividend.
EL: Can you also talk about another SMP investment, North Pittsburgh Systems (Nasdaq: NPSI ) ?
LG: We are planning on waging a proxy contest, nominating two directors. We've visited them and told them, "Look, your balance sheet can handle a lot more debt just to get to the industry average. We think you should borrow. You also have a cellular partnership which could bring a nice price in a sale, and you have substantial net cash. You can buy in half your stock, and/or increase your dividend." They turned us down.
They offered to buy us out under the market. We said, "We don't accept the greenmail -- if you want to buy us out, make an offer to all the shareholders." We said, "The business is likely to deteriorate; we think you can maximize shareholder value by selling the company." There are two things that make sense for a little telecom. They can't compete with the cable companies, which are bigger. They can't afford TV programming costs, can't get the subscribers with cable companies offering Internet and phone packages at lower prices. It makes sense to sell out to get rid of overhead -- you don't need two CFOs for such a small subscriber base. We suggested they sell the company. The upcoming election will be very important.
Check back later ...
As you can see, Larry has an incredible array of experiences to draw upon when picking investments, and the kind of value investing/activist style where, if necessary, he can create his own catalyst. Check back tomorrow for the second installment of this interview.
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.